The endgame for tax paradises

The revelations in Paradise Papers will lead to a renewed call for curbs on tax havens

Like Themyscira, the magical island of the Amazons that lay open to the sun, but was hidden from the human eye, offshore tax havens that operate under a thick fog of secrecy and confidentiality have evaded scrutiny so far.

But as losses to countries due to global tax evasions mount, intolerance towards these tax havens is also growing. Leaks such as the Panama Papers and the Paradise Papers provide ammunition to governments to put pressure on these jurisdictions to improve their disclosure and information sharing. If these jurisdictions become more transparent, corporates will stop using them to hide their unaccounted money.

Paradise Papers leaks

The Paradise Papers included nearly 7 million loan agreements, financial statements, emails, trust deeds and other documents drawn over the last 50 years by Appleby, a law firm in Bermuda and Asiaciti, a Singapore-based, family-owned trust company. The documents reveal how companies set up entities in low-tax jurisdictions to save tax in overseas deals.

Almost 714 Indians are named in the documents making India rank 19th out of 180 countries in terms of number of entities featuring in the leak. Indian company Sun Group is Appleby’s second largest client with 188 offshore entities. Other Indian companies that dealt with Appleby include GMR group, Vijay Mallya’s personal offshore company, Havells, Religare, United Spirits, etc.

Many individuals, including Niira Radia, Dilnashin (Sunjay Dutt’s wife) and Amitabh Bachchan have also used the services of Appleby to manage overseas transactions.

Avoidance vs planning

But it would be wrong to conclude that all those named in the documents have violated Indian laws and will be prosecuted. Many of these deals could be within the framework permitted by laws of the country.

The thin line separating ‘tax avoidance’ and ‘tax evasion’ needs to be understood first to decipher why this web of intricate transactions was spun.

It had become acceptable for businesses to use various means to reduce their tax outgo, since the beginning of the 20th century. This was established in the case between IRC and the Duke of Westminster, decided by the House of Lords in 1936.

The Duke, in one of the earliest displays of innovative tax planning, had paid his domestic employee in deeds of covenants on which tax deduction could be claimed instead of wages which were not tax deductible. The decision of the House of Lords that “every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be”, became the corner-stone for future tax avoidance arrangements.

With companies and tax consultants exhausting all the ideas to evade tax with domestic tax laws, they turned their attention to countries that had extremely low or nil taxation, followed strict secrecy codes and had a robust ecosystem of tax consultants, accountants and law firms to enable setting up of offshore entities in their jurisdictions.

Routing purchase of overseas assets or other transactions through these paths ensured that the money could not be traced back to them.

But in the eighties, British courts moved away from the Westminster Principle. Indian courts too went against innovative tax arrangements in the McDowell case.

Overseas transactions

The main difference between Panama Papers and Paradise Papers is that while the former revealed individuals’ links with offshore entities to move money, Paradise Papers mainly relate to dealings of Indian companies, especially with relation to formations of Trusts in offshore low-tax jurisdictions.

Appleby is reported to have helped incorporate 2,700 Trusts. These were set up in various offshore tax havens like British Virgin Islands, Cayman Island, Guernsey, Hong Kong, Isle of Man and so on. Appleby provided dummy directors for the board of offshore companies.

That said, Indian laws do not bar individuals or companies from setting up overseas Trusts. Money once moved overseas can be used for current and capital expenditures. There are no reporting or repatriation requirements after the initial approval.

The problem will arise if the money that is moved overseas is black money on which no tax has been paid.

There could be FEMA violation if the funds moved to the Trusts have not been disclosed in the companies’ books or to the tax authorities. It is also common for companies to over-invoice exports and move the surplus funds to these entities or use the hawala route to move funds. These can lead to prosecution too.

BEPS, GAAR

With India becoming a signatory to the OECD’s BEPS agreement and adopting the General Anti Avoidance Agreement from this year, companies and individuals are going to be thinking twice about using such practices to evade tax in the future.

Also, the growing clamour for making the low-tax jurisdictions increase their tax rates towards the mean and increase cooperation in information sharing, signals that the days of these tax paradises are numbered.

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